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Thursday, January 25, 2007

China vs. India - part 2

The Economist's latest Economics Focus compares China and India. The piece, Reading the tea leaves, concludes that "India's boom may be less impressive than it seems":

India has been swept by optimism that its economy can do as well as China's. A recent article in the Economic Times claimed that the growth in India's total factor productivity (TFP), the efficiency with which inputs of both labour and capital are used, had accelerated, whereas China's had slowed owing to wasteful investment. As a result, the article boasted, rising productivity—the main driver of long-run economic growth—is now running neck and neck in the two economies. Close inspection of the numbers, however, reveals that China remains well ahead.

Both India and China have large populations, low incomes and rapidly rising GDP, yet the composition of their growth has been quite different. A recent paper* by Barry Bosworth and Susan Collins, of the Brookings Institution in Washington, DC, explores the sources of expansion in both countries, breaking down total GDP growth into increases in inputs of labour and capital, and gains in TFP. In the period 1993-2004, China's GDP grew by an average of 9.7% a year, India's by 6.5%. Employment increased faster in India than in China, but this was more than offset by a much slower rise in output per worker: only 4.6% a year, compared with 8.5% in China. This reflected both stronger capital investment in China and much faster growth in TFP, which increased at an annual rate of 4% against India's 2.3% (see left-hand chart). Contrary to the popular claim that China's TFP growth has slowed, the authors find that it has accelerated from a pace of 3.6% in 1978-93.

These figures challenge the conventional wisdom that China's growth is more dependent than India's on investment than on efficiency gains. Over the past decade TFP has in fact accounted for a bigger slice of GDP growth in China than in India. Thanks to economic reforms, India's TFP growth has improved from its paltry 0.2% a year in the 1960s and 1970s before the economy was opened up, but it is still much slower than in China. Worryingly, the figures also show that India's TFP grew more slowly in 1999-2004 than in 1993-99. Since 2004, TFP growth has probably spurted (the figures are not yet available), but this may reflect a cyclical boom.

The relative performance of the two countries varies by sector (see right-hand chart). In agriculture, China has enjoyed much faster productivity growth. Indeed, India's TFP growth in farming has fallen since 1993, dragging down overall TFP growth because agriculture still employs a large share of the population. In 1978 it accounted for 71% of workers in both India and China. Now the respective figures are 57% and 47%. India therefore has huge scope to sustain rapid growth by shifting workers from agriculture to more productive jobs in industry and services.

According to conventional wisdom, Chinese workers have shifted largely from farming to factories, whereas India's growth has been driven largely by services, from call centres to writing software. In fact, jobs in services have expanded more strongly in China than in India. Since 1993 the rate of increase of China's service-sector jobs has been four times that in industrial jobs and has exceeded that in India. China's real output of services has not only grown almost as fast as its industrial output, but also faster than India's services.

Indeed, a larger proportion of workers is employed in services in China than in India. However, the share of services in GDP is much smaller in China (33%, against India's 50%), because Chinese industry is so much more productive. India's industrial workforce, including small firms in the informal sector, has been growing much faster than China's—by 3.6% a year since 1993, against only 1.2% in China—but its industrial output has lagged behind China's because its productivity has grown more slowly. This is due in part to rigid labour laws, which prevent the most efficient use of workers, and to a lack of modern infrastructure. Since 1993, China's industrial TFP has grown by an annual average of 6.2% compared with a measly 1.1% in India—barely any faster than before the economic reforms of the early 1990s.

Comments

Nonetheless, the Chinese economy doesn't add up. China seems to be dumping much of its goods below true costs (if negative externalities are included) just so it can dump even more goods below true costs (while larger volumes lower price). So, employment levels are kept too high and tax revenues increase. Also, slave wages and flexible (or disposible) labor may keep prices low. Unless competitors are driven out to raise prices, which generally hasn't been the case, because export-led economies continue to maintain high employment and remain price competitive, although China has gained market share, it may be a house of cards.

I'm still not convinced that china will one day break down because of it's central planning. they can always mend the functioning of economy with little bit of shocks, it's not the kind that collapse on one fine day.

I agree with Harsha. I don't believe that China will suddenly collapse. Its economy is too distributed for that. But I do think that the mounting negatives are very worrying. The Chinese themselves say that they have done too little to handle the environmental effects of uncontrolled development, and in fact, when you look at the number of fossil fuel power station under construction, that will probably get worse. I wonder if we need to put numbers on these negative effects in order to measure just where the Chinese economy is going. Just having a positive trade balance may not help if behind the scenes they are making their country unliveable. And just having a "liberal" economy may not help if political power is used to suppress the sorts of environmental protests that do seem to have an effect in the West. In other words, political authoritarianism may be just too good at keeping the lid on the boiling pot.

The India-more-efficient-than-China theory is based on the fact that China saves 50% of its GDP and produces 11% GDP growth, while India saves 29% of its GDP and produces 9% growth.But it's true that Economic Times is hardly unbiased---it's editorial stance is flag-waving jingoism combined with censorship of unwanted information. For instance, the suicides by tens of thousands of cotton farmers has been largely ignored, at least it's buried discreetly in the inside pages.
China is not going to collapse. All over the region, from Korea to Taiwan to Indonesia, regimes have allowed more freedom as they became richer. No reason why China shouldn't do the same.

China's economy seems to be in disequilibrium more than any other country. For example, the U.S. tends to optimized the combination of production and consumption, e.g. losing little in production to gain a lot more in consumption. However, China loses more in consumption than what it gains in production. China doesn't shift towards an optimal combination, while the U.S. tends to shift towards that point. The U.S. has no control over foreign economic policies. So, it should make the best choices. In the mid and late '90s, U.S. actual output generally exceeded potential output. However, since the 2001 recession, U.S. actual output has generally been below potential output. When China (or the rest of the world) is overproducing, the U.S. should increase production when it's underproducing. This will cause the rest of the world to overproduce even more (because of increased U.S. demand), while U.S. production increases. Consequently, the rest of the world moves away from optimal production, while the U.S. moves towards optimal production. The rest of the world is overproducing more than the U.S. is underproducing. On the other side, the U.S. is overconsuming even more than the rest of the world is underconsuming. So, U.S. living standards rise faster than the rest of the world.

Jon, It's possible. However, Americans may be busy overproducing on weekdays and overconsuming on weekends. What's important is capital creation, which the U.S. does better than any other country. China attempts to create capital through low wages, disposible employment, negative externalities, etc. Many Western European countries create less capital, because of high taxes, social programs, wage rigidies, etc. Lower interest rates and lower prices induced U.S. demand, which caused saving to fall and debt to rise. However, Americans bought more, real assets and real goods, for less. China's exports to the U.S. was $260 billion and China's imports from the U.S. was $50 billion. Basically, the U.S. produces fewer and higher value goods in older industries, while shifting resources into newer industries. Many "normal goods" in the U.S. are "luxury goods" in China, because of the large disparity in per capita incomes. Also, I may add, if China is not paying the cost of $1 billion in pollution for each $1 billion in profits, it may not be creating capital. The U.S. has its own set of problems. For example, there has been a massive transfer of assets from upper income Americans, who tend to save, to lower income Americans, who tend to spend. Will the lower income or marginal homeowners continue to maintain their living standards? After years of rising homeownership, zero percent financing of vehicles and other durable goods, cheap imports, etc., financed to a large extent by home equity, many will have a tough time maintaining autonomous consumption. However, Americans have been adept maintaining autonomous consumption. So, most may at least hold what they gained.

Lafayette, Asian export-led economies are buying U.S. Treasury bonds to maintain their high employment levels and raise tax revenues. U.S. capital creation and foreign investment in the U.S. are not mutually exclusive. The U.S. is much closer to optimal growth than most export-led economies. China is producing at an extremely large suboptimal level.

Lafayette, of course, economic laws don't apply in China :) China induced U.S. consumption, which caused the U.S. to underproduce (i.e. large U.S. negative net exports). China tends to produce goods with declining prices and the U.S. tends to produce high value goods, while U.S. per capital income is over 25 times more than China's per capital income. So, China makes up in volume what it loses in value (i.e. deteriorating terms of trade) and China's consumers cannot afford many U.S. goods. The imbalance worsens, because wages are kept low in China, to make up for declining prices, and deteriorating terms of trade lower prices even more. The U.S. maintains stimulative monetary and fiscal policies to close the negative output gap. However, greater U.S. output (and income) causes China to overproduce even more. Consequently, the U.S. underproduces less than China overproduces. So, the U.S. economy is much closer to optimal growth than China.

AE: "China tends to produce goods with declining prices and the U.S. tends to produce high value goods"

In your dreams.

The US designs hi-value products and produces them abroad. Eg; The major fab plants of AMD are in Germany and Taiwan.

Germany? Yes, because it has high-output and low manpower content in the manufacturing process of chips.

Besides, China is now going to go upmarket whilst developing new markets (Africa) for its cheaper non-qualified labor content products.

They are doing EVERYTHING right. (For the moment.) They've cornered the global market on gadget-goods. They have machine-tool design shops established in Germany to learn the machine-tool market, which they will inevitably bring back to China loc-stock-and-barrel. They signed major agreements with Airbus to produce aircraft in China and with Westinghouse to obtain nuclear generating plant technology. They are investing heavily in Africa to become a major buyer of basic resources (particularly metals.)

Enough of your hubris. It's what got American into its present mess. Superlatives about American industry simply don't work anymore, AE, in the face of what is factually obvious.

The King is naked: American industry is in deep decline. And, the sooner America realizes this, the better.

Lafayette, the U.S. leads the rest of the world combined in Information-Age and Biotech Revolution firms, which tend to produce high value goods. Also, about half of the largest corporations in the world are American. Older U.S. industries tend to produce more output per unit of input, while newer U.S. industries tend to produce higher value output per unit of input. U.S. actual output has generally been slightly below potential output, since 2001, although U.S. actual output slightly exceeded potential output in the mid and late-'90s. So, the U.S. had a slight economic boom/bust cycle. U.S. actual output may rise to and slightly above potential output over the next few years, in part, through increased exports. China has consistently followed a growth at any cost policy. Cheap imports have allowed China to gain global market share. However, the cost was too high, given intense global competition. Your assumption that China is doing everything right is ridiculous.

Also, I may add, China's cost of gaining and holding market share has been high, because of the abundance of low-skilled labor in the global economy. The only way China can avoid intense global competition is to continue keeping prices low, which may become increasingly difficult. It seems, China is working almost for free, when "true" costs are taken into account.

Moreover, some Chinese factories employ over 200,000 workers. In any other country, a factory that large is suboptimal to a large extent, because if demand falls, fixed costs (or sunk costs) still have to be paid. Consequently, an economic contraction in China may be devastating. So, prices are likely to remain low.

T.O., I didn't save the source. It was in a paragraph of an article. Lafayette, I understood what you wrote. I wonder if you know what you wrote. U.S. revenues and profits in Information Age and Biotech Revolution firms lead the rest of the world combined, in part, because offshoring some lower-skilled jobs at cheaper wages increases productivity, e.g. lower input costs and high output prices. Consequently, the U.S. creates more capital and high-skilled jobs. The E.U. has more restrictions on offshoring, e.g. labor laws, unions, subsidization, etc. Yet, E.U. unemployment is much higher than the U.S., while E.U. per capita GDP is much lower. Also, I may add, large economies expand more slowly than small economies and the U.S. economy will continue to become a smaller proportion of the world economy. However, that doesn't necessarily mean the U.S. economy is declining.

T.O., I tried to find the article I read. There seems to be many very large toy factories in China. However, I found the following related article with the link below. "A big problem in the toy industry is the occupational and safety hazards because of the paint. I don't think enough attention has been paid to this," said Dr Chan. As temporary migrant workers, the girls are rarely covered by medical insurance although this is compulsory according to Chinese labour law. Some factories employ 200,000 workers, others are sub-sub-contractors with anything from a few dozen to 2,000 employees at the peak order season."

Also, I may add, it seems globalization benefits rich countries more: "An investigation into the price of a Mattel Barbie doll, half of which is made in China, found that of the $10 retail price, $8 goes to transportation, marketing, retailing, wholesale and profit for Mattel. Of the remaining $2, $1 is shared by the management and transportation in Hong Kong, and 65 cents is shared by the raw materials from Taiwan, Japan, the U.S. and Saudi Arabia. The remaining 35 cents is earned by producers in China for providing factory sites, labour and electricity. "That investigation was two years ago. Since then the toy market has become more and more competitive," May Wong said." Also, I heard domestic oil refineries earn more profit per barrel of oil than foreign oil producers, although that doesn't seem possible. http://www.globalexchange.org/campaigns/sweatshops/china/501.html.pf

This is a good platform to share ones views on various issues related to economy. I am a regular reader of this. It is a very good effort from the NewEconomist to comeout with such a informative and communicative blog. Congratulations!!!

I am a brasilian and we we used to learn at school almost exactly the Acemoglu’s thesis, but a long time before he published his papers!
But, who knows that? Almost no one read papers or books in portuguese.
I understand that, but if you will speak about Latin America, then I expect you read spanish and portuguese!

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